Solow economic-growth model

Solow economic-growth model

In the HARROD ECONOMIC-GROWTH MODEL and the DOMAR ECONOMIC-GROWTH MODEL, a constant CAPITAL-OUTPUT RATIO is assumed so that there is a linear relationship between increases in the CAPITAL STOCK (through INVESTMENT) and the resulting increase in output. For example, if it requires £3,000 of capital to produce £1,000 of output then the capital-output ratio is one-third, and this is assumed to apply to successive additions to the capital stock. By contrast, the Solow model utilizes a production function in which output is a function of capital and labour, with capital being substitutable for labour but with varying degrees of perfection and which displays DIMINISHING RETURNS. Thus, if capital is increased relative to labour, the resulting increases in output become progressively smaller. On this assumption of a variable capital-output ratio as a country's capital stock increases, diminishing returns set in and produce progressively smaller increments in output. Sustained economic growth thus requires not only CAPITAL-WIDENING but also CAPITAL-DEEPENING investment. Specifically, TECHNOLOGICAL PROGRESSIVENESS (new production techniques, processes and methods, and new products) plays a necessary role in offsetting diminishing returns to capital as the capital stock increases. See NEW AND OLD PARADIGM ECONOMICS.